... [The public] can learn more about the value of debt by tracking the prices of credit-default swaps, he says.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The swaps, which are derivatives, are an unregulated type of insurance in which one side bets that a company will default and the other side, or counterparty, gambles that the firm won’t fail. The higher the price of that protection, the greater the perceived risk of default.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

“We know the spreads are more accurate than ratings,”... 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In July 2007, credit-default-swap traders started pricing Bear Stearns Cos. and Lehman as if they were Ba1 rated, the highest junk level. They pegged Merrill Lynch & Co. as a Ba1 credit three months later, according to the Moody’s model.

Each of those investment banks was stamped at investment grade by the top three credit raters within weeks of when the banks either failed or were rescued in 2008.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

“When you get into a situation like we’re in right now with AIG, the rating agencies are basically trapped into maintaining high ratings because they know if they downgrade, they don’t only have this regulatory effect but they have all these effects,” Partnoy says.

“It’s all this stuff that basically turns the rating downgrade into a bullet fired at the heart of a bunch of institutions,” he says.

....

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In September, Moody’s and S&P downgraded AIG to A2 and A-, the sixth- and seventh-highest investment-grade ratings. The downgrades triggered CDS payouts and led to the U.S. lending AIG $85 billion. The government has since more than doubled AIG’s rescue funds. [my emphasis]